Any fiscal cliff deal will do for oil, gold

Analysis: Short sellers ready to pounce if negotiations drag on

U.S. House Minority Leader Nancy Pelosi (D-CA) speaks next to House Minority Whip Steny Hoyer (D-MD) during a meeting with business leaders on Capitol Hill.

SAN FRANCISCO (MarketWatch) — Commodity markets, particularly gold and oil, have been clinging to hope that the U.S. government will strike a deal to avoid the so-called fiscal cliff, but starting to trade as if it won’t.

Gold
GCZ2, +1.13%
and oil
US:CLF3
prices marked their third-straight losing session on Wednesday, in part due to uncertainty linked to the fiscal cliff, which refers to a combination of hundreds of billions in spending cuts and tax hikes that take effect at the start of the year if the nation’s lawmakers can’t reach a compromise.

“As we get closer and closer to the end of the year or, more importantly, when Congress goes home for the Christmas holiday, buyers in all markets will not commit to the market,” said Tariq Zahir, managing member at Tyche Capital Advisors. “We are already starting to see that. But as we get closer, we feel shorts will start to put some money to work.”

So as the wrangling in Washington wears on, so will the volatility in the commodities markets.

“When it looks like a deal will be reached, all markets react positively and when it looks like a deal will not be reached, the markets react negatively,” said Bradford Cooke, chief executive officer and director of Endeavour Silver Corp.
EXK, -2.06%
That’s because “slashing spending and raising taxes reduces economic activity … and pushes the U.S. economy into recession or even worse — deflation and depression.”

But right now, there are many different variations on potential deals to avert the cliff.

They include a $4 trillion deficit reduction over 10 years, plus some reform to entitlement programs such as Social Security or Medicare, and an extension of the former President George W. Bush-era tax cuts and either preventing or spreading out the time period for cuts to defense and non-defense spending.There’s also a proposed deal that would pursue tax reform and possibly entitlement reform in another six months.

But for commodity traders, the details aren’t quite as important as simply finding out whether a deal is reached or not — and if there’s a deal, whether it’s a short-term or long-term fix.

A no-deal scenario isn’t likely, while the chances for a complete resolution with far-reaching decisions about higher revenues and spending cuts, including cuts in entitlements, are slight, said Malcolm Gissen, co-manager of the Encompass Fund
US:ENCPX

He expects to see a partial solution that will leave many issues unresolved. That can be viewed as a positive as the cliff would be avoided, he said, and would, in the short term, be good for the dollar and negative for gold.

Gold’s safe-haven tendencies

Even so, for gold there’s potential for price climbs under just about every fiscal-cliff scenario, depending on who you ask.

“The biggest impact the fiscal cliff issue has on gold is its effect on risk taking in the markets,” said Brien Lundin, editor of Gold Newsletter. “When there’s hope of a deal in the air, a ‘risk on’ sentiment takes hold that buoys the gold price.”

“Conversely, when pessimism reigns supreme, speculators pull their horns and go to cash, which hurts gold on the margin,” he said.

But Elliott Orsillo, co-founder and portfolio manager at Season Investments LLC, pointed out that the type of deal can impact gold in different ways.

The more a compromise seeks to “kick the can down the road” by not addressing the problems at hand, the more bullish it will be for commodities in general, he said. “It would be most bullish for gold since it would further degrade the confidence in the U.S. dollar and the U.S. government’s ability to make good on their debt.”

A weaker greenback tends to lift prices for dollar-denominated commodities, including the yellow metal.

A good example of such a compromise would be if the government was to agree to pursue tax reform in another six months, essentially dragging out the issue.

“That would light a fire under the metals because it would signal a complete lack of serious resolve to create a cure,” said Phil Storer, director of trading at Dillon Gage Inc.

But if a deal was reached on a $4 trillion deficit reduction, that “would hurt both gold and silver, both of which owe their lofty values to a continuing demoralized dollar,” he said. The dollar, instead, should get a bounce because it would appear to the world, at least initially, “that we are doing something significant to avoid financial collapse.”

And if there was no deal to avert the fiscal cliff, commodities would “likely sell off on global growth fears,” though gold will probably hold up better than other commodities, “as it could see some inflows as a safe-haven asset,” said Orsillo.

Then there’s the camp that believes that no matter happens, gold will benefit.

“Almost no matter what — barring some bizarre miracle like Democrats and Republicans deciding to sing … ‘Give Peace a Chance’ and holding hands, coupled with an unexpected Internet-revolution-esque surge in productivity — what they’ll agree to or what will be forced on the economy will be viewed as inflationary,” said Seth Rabinowitz, who covers commodities as a partner at Silicon Associates. Gold is often seen as a hedge against inflation.

And with a resolution or not, the U.S. will likely see accelerated increases in taxes and money printing and that points to higher prices for safe-haven gold, he said.

Oil’s dilemma

The oil market, on the other hand, has to worry about ample supplies on top of the impact a fiscal-cliff deal or no deal would have on demand.

“If a deal is not struck, the U.S. economy will grind to a halt which will likely find the U.S. leading the world into another global recession,” said Roy Friedman, executive vice president of business development for Dillon Gage Metals.

“It is difficult to say what would happen to gold and oil under this scenario as the weak U.S. dollar will propel both higher, but a global economic downturn would certainly have a negative impact on oil prices,” he said.

Tyche Capital’s Zahir said that if leaders fail to make a deal and the economy foes over the cliff and falls into recession, that would add more pressure to an already well-supplied market and demand would take another hit, possibly taking crude down to the $70-per-barrel level in “rather quick fashion.”

At the same time, the cuts to military spending will hurt oil demand, since the U.S. military is the world’s single-largest industrial consumer of oil, said Phil Flynn, senior market analyst at Price Futures Group.

Certain compromises on the fiscal cliff may benefit oil prices, but the impact isn’t as clear-cut as it may be for gold.

“Any ‘deal’ made to extend tax cuts or water down the fiscal cliff legislation would send a clear message to our trading partners that the U.S. is not willing to go through austerity and this would benefit gold the most,” said David Morgan, publisher of The Morgan Report.

“Other nations would see the U.S. as a paper tiger and would know the U.S. dollar is doomed to further depreciation,” he said. “Oil could benefit but it is not as clear a picture because fiscal expansion would pressure all commodities to the upside but other than monetary assets (gold and silver), oil is not always considered a store of value.”

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